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Menace to Solvency

If you thought there was one lesson from the financial crisis of the last 5 years, it would likely be that governments need to have the ability to cut themselves loose from large financial institutions, meaning that they have the power to liquidate or restructure them without incurring massive fiscal obligations. And when people look around for a model of how this process might actually work, they cite the US Federal Deposit Insurance Corporation (FDIC).

It may be worth noting therefore that in the spending cuts bill (H.R. 6684) hastily assembled by US Congressional Republicans on Thursday to drum up votes for their fiscal cliff solution, the FDIC would have lost its expanded 2010 Orderly Liquidation Authority to liquidate or restructure bank holding companies, bank affiliates, or non-bank financial intermediaries (like AIG) — its power prior to then only included banks that it directly insured. It’s not like the bill proposed a better alternative — had it passed, it would have been simply a reversion to the 2008 situation, which worked out so well with Lehmans and AIG. And this was being presented as a solution to the country’s long-term economic problems. Lesson: the fiscal cliff isn’t just about fiscal policy. There are other very damaging agendas being pursued under its cover.

The FDIC’s record of liquidation is hardly a model for the different challenges that face a Lehman or AIG. Too big to fail is just that, whether the FDIC is there or not. The FDIC takes insolvent banks, sells the assets at 80 cents on the dollar to politcally connected parties and spreads the costs among remaining solvent institutions. Not that hard to look like you’re doing a good job with Other Peoples Money …